Loyalty’s Core Demand: The Defining Role of Good Faith in Corporation Law
The duties owed by independent directors of large corporations to monitor the corporation’s affairs have never had more political salience. Given the Enron-era debacles, the recent meltdown in our nation’s financial sector, the dependence of workers on equity investments to secure their retirements, the globalization of American corporate law principles, and the complexity of managing corporations with international operations, the legal standards used to evaluate whether directors have complied with their fiduciary duties will be a subject of growing international policy interest.
This article addresses an important dimension of that issue by examining the role of good faith in corporate law, and its use as the definition of the state of mind with which a director must act to comply with the fiduciary duty of loyalty. In particular, this article employs an historical, etymological, and policy-oriented analysis to address the question of whether the obligation of directors to act in good faith is a separate, free-standing fiduciary duty, or a fundamental aspect of the core duty of loyalty. We conclude, consistent with the Delaware Supreme Court’s recent decision in Stone v. Ritter, that in the American corporate law tradition, the basic definition of the duty of loyalty is the obligation to act in good faith to advance the best interests of the corporation. What this article also shows is that the duty of loyalty has traditionally been conceived of as being much broader than the duty to avoid acting for personal financial advantage. The duty of loyalty also precludes acting for unlawful purposes, and affirmatively requires directors to make a good faith effort to monitor the corporation’s affairs and compliance with law.
Finally, we highlight a critical policy implication resulting from Stone v. Ritter, which is that an independent director who is accused of having failed in her monitoring duties may only be held liable if a court finds that she breached her duty of loyalty by consciously failing to make a good faith effort to comply with her duty of care. By requiring a finding of bad faith before imposing liability on an independent director, the corporate law, as explicated by Stone, protects the policy interests underlying the business judgment rule from erosion.